Chap. 15 Credit analysis Flashcards
A rating agency monitors:
The credit quality of the issuer and can reassign a different credit rating to its bonds (upgrade or downgrade)
A credit rating is a forward looking assessment of:
- The probability of default
2. The relative magnitude of the loss should a default occur.
Before an issue’s credit is changed, a rating agency will place a warning or “watch” that it is reviewing the issue for a potential up or downgrade. T or F?
True
What are the “Four C’s” of credit?
Character
Capacity
Collateral
Covenants
Character
The ethical reputation, business qualifications-operating record of the board, managent, and execs. responsible for the use of the borrowed funds and its repayment.
Capacity
The ability of an issuer to repay its obligations.
Collateral
Pledging of traditional assets to secure the debt AND the quality of and value of those unpledged assets controlled by the issuer.
Covenants
Imposed restrictions on how management operates the company and conducts its financial affairs.
Use of the statement of cash flows.
Used to analyze the ability of an entity to repay its financial obligations and to gain insight into the entity’s financial methods, capital investment strategies and dividend policy.
Use of profitability ratios
These help explain the underlying causes of a change in entities revenue.
What is the best way to predict future downward earnings?
Through a careful analysis of accounts receivable and inventories; two signs of trouble are a larger than average accts receivable balance and/or bloated inventory.
Three indicators to asses entity’s ability to satisfy its debt obligations.
- Short term solvency ratios
- Capitalization ratios
- Coverage ratios
Short term solvency ratio
Measures the ability of the firm to satisfy its debt obligations.
Capitalization ratio
The extent to which an entity relies on debt financing.
Coverage ratio
The ability of the entity to meet obligations brought about by debt financing
Better view of entities activities: income statement and
Funds from operations Operating cash flow Free operating cash flow Discretionary cash flow Pre financing cash flow
Negative covenants
Restrict borrower from taking certain actions such as: various limitations in the company’s ability to incur debt.
Two types of interest/fixed charge coverage tests:
Maintenance test = requirement of earnings available to be at least a certain minimum figure.
Debt inccurance
Assessing management quality:
- Strategic direction
- Financial philosophy
- Conservatism
- Track record
- Succession planning
- Control systems
What are the four informational categories to consider when assessing tax-backed debt?
- Overall debt burden
- Ability/political discipline to maintain sound budgetary policy
- Specific local taxes and intergovernmental revenues available to the issuer.
- Issuers overall socioeconomic environment.
Underlying rating principal for revenue bonds.
Will the project being financed generate sufficient cash flows to satisfy the obligations due bondholders.
The principles involved in analyzing the credit risk of a revenue bond are the same as for a corporate bond. T or F?
True
In assessing the credit risk for revenue bonds, the trust indenture and legal opinion should provide legal comfort in the following bond security areas:
- The limits of the basic security
- Flow of funds structure
- Rate or user charge covenant
- Priority of revenue claims
- Additional bonds tests
- Other relevant covenants.
